According to the economic theory of fiscal federalism, Research, Development and Innovation (RDI) is better managed and financed at EU level.7 In the area of RDI,8 the need for a central budget is well documented, as the potential economies of scale are very large.
The EU budget’s role in R&D has seen an important change over the last decades, from a policy focusing on open calls for support to fundamental research, to an instrument of industrial policy. It is now generally recognised that the economic welfare of European nations depends on long-term growth and sustained industrial competitiveness. This is
7 For an overview: J. Núñez Ferrer and Filippa Figueira (2011), “Achieving Europe’s R&D Objectives:
Delivery tools and the role of the EU Budget”, Report No. 6, SIEPS, Sweden.
8 The expression ‘RDI’ is used here, as it is more appropriate than the more restrictive term R&D, as it includes non research-based innovation.
Infrastructure
Horizon 2020
Equity and Risk Sharing Instruments European Structural and Investment Funds Risk sharing (e.g. project bonds) and equity
instruments
achievable through the development of high added value goods and services which require continuous investment in RDI.
The Seventh Framework Programme (FP7) for the programming period 2007–2013 had a budget of just over €50 billion for its interventions. The follow up Horizon 2020 program has seen its budget increase to €70.2 billion. Although the budget represents less than 5% of total government expenditure on research in the EU, it has a significant impact in the specific areas in which it intervenes (e.g. in energy research a third of the public research budget is financed by the EU). The Financial Instrument of the FP7 assistance in the area of RDI at EU level provides important advantages:
It promotes cross-border collaboration and economies of scale, thereby capturing the full capacity within the EU by improving cooperation and coordination;
It addresses RDI projects that are too big for any one member state or requires coordinated actions among member states to provide value;
It copes with the risks associated with new RDI projects and helps to reduce the risk of duplicating national or regional initiatives implemented in an uncoordinated fashion;
and
It also allows for transfer of knowledge and the build up of new capabilities in institutes participating in collaborative cross border research.
Through the Framework Programmes, the EU principally offered grants with the objective to strengthen industrial competitiveness and to meet the research needs of other EU policies, thereby contributing to the creation of a knowledge-based society. RDI support should contribute towards promoting growth, sustainable development and environmental protection. FP7 promoted excellence in scientific and technological research, development and demonstration through its programmes. An OECD model has been used by the European Commission to estimate the impact of the EU’s 6th and 7th Framework Programme:
for each Euro spent the Value Added in the business sector is estimated to have increased by
€13,9 which can be considered a very good result.
A 2010 interim evaluation of the Framework Programme identified concrete positive effects of the FP7 including a wide diversity and high quality of projects under both Cooperation and People programmes, the establishment of research infrastructure, and leverage in promoting national research efforts.
However, one of the central weaknesses of EU’s FPs has been the low level of private sector involvement and the lack of market deployment of successful research outputs. Figure 4 shows the rationale for support beyond traditional academic RDI. For many research outputs, which can potentially lead to new products, public grant support does not cover the high costs of testing at industrial scale and of marketing that would be required to launch the innovation. These costs are often referred to as the ‘valley of death’ in the literature or the
‘technology death risk area’.
To bridge the gap between academic research, and large scale (real life) demonstration and the market, FP7 offered additional support, in particular through a new Financial Instrument called the Risk Sharing Finance Facility (RSFF). The RSFF is a guarantee instrument supported by European Investment Bank (EIB) loans, and is an important instrument to bridge the gap. RSFF provides risk capital aimed at covering potential losses in the financial
9 Presented in Box 10 of p. 10 of the Commission staff working paper accompanying the impact assessment of the Horizon 2020 proposals (SEC(2011) 1427 final) of 30 November 2011.
sector from RDI investments over the advanced stages of innovation, demonstration and deployment. It supports private projects with a high-risk profile to become bankable.
By investing in high-risk projects that would otherwise not be implemented, the RSFF aims to ensure that the additionality principle is preserved. The RSFF’s expert group evaluation concludes that there is no evidence of a crowding out of other national/private financial sources, but rather a complementarity. The demand for RSFF R&D funding is much higher than what is provided by the market. The high leverage factor (in excess of 10) has significant impact on the EU innovative economy – with €1 billion by the EU budget and an equivalent amount by the EIB, the RSFF was expected at its inception to raise private risk capital in the value of approximately €10 billion over the 2007–13 period. In its mid-term evaluation report of 2010, the EIB noted that the leverage achieved as of end 2009 reached factor 14, triggering some EUR 16.2 billion of investments in research and innovation. In 2010, the European Commission also introduced the Risk Sharing Instrument (RSI) to cater for the special financing needs of innovative SMEs (this is described in more detail in chapter 5).
Figure 4. Technology cycle and financial needs
Source: Núñez Ferrer et al. (2011), SET-Plan, from concept to Successful Implementation, CEPS Task Force Report, May, p. 24.
Innovation is at the core of long-term economic growth in the European Union. RDI is one of the most suitable areas of investment at European level. This allows to pool resources and to improve coordination across the EU, to avoid duplication and to generate economies of scale.
It also allows for large collaborative projects to emerge, which no member state would be able to finance by itself.
In general, providing access to risk capital is a promising and key success factor. The RSFF has started at a moment where investment in R&D has been affected by the crisis, providing a welcome financial injection in an area of highest priority for the EU.
There is some evidence that the actions during the 2007-2013 MFF have had an impact. Since 2009, and despite the financial crisis, the share of RDI investment in the GDP of the EU has crossed the level of 2% of GDP for the first time and is steadily increasing. RDI investment
tends to be sensitive to downturns, but the policy emphasis on RDI as an important element of the sustainability of Europe’s economy seems to have had a considerable effect.
For the next programming period 2014-20 the EU, Horizon 2020 will become the biggest EU Research and Innovation programme to date with nearly €70.2 billion of funding available over 7 years (2014 to 2020). Together with a streamlining of the process, and a more focused approach, Horizon 2020 should increase the value added it generates. The goal is to ensure Europe produces world-class science, removes barriers to innovation and makes it easier for the public and private sectors to work together in delivering innovation. The objective of new FI is to complete and further develop the European Research Area and to create a genuine single market for knowledge, research and innovation.
The Horizon 2020 programme envisages to set aside €4 billion for financial instruments.
Given the high leverage of the RSFF and RSI, the financial instruments’ leverage may reach over €40 billion, nearly doubling by itself the research budget. If the funds recovered were to be reused (revolving funds), the leverage would be increased even further.
Despite the importance of Horizon 2020 and of public funding support in general, it is important to point out that it is not only funding that promotes progress in innovation, but also the regulatory environment and the macroeconomic conditions. The share of public investment in RDI in the EU is not very different from the levels in the US or Japan, but the challenges arise in the private sector.10 Much of the private RDI investment is performed by companies operating internationally, and those based in the EU can easily shift their RDI operations and market launch to other regions. The environment for commercial RDI may well not be optimal in the EU and attention should also be paid to this factor. The European Commission also warns that quality of funding is more important than quantity.11
10 K. Uppenberg (2009), R&D in Europe, Expenditures across Sectors, Regions and Firm Sizes, CEPS-EIB special report, Brussels.
11 Box 3, p. 10, European Commission staff Working Paper accompanying the impact assessment of the Horizon 2020 proposals (SEC(2011) 1427 final) of 30 November 2011.
Box 2. Contribution of EU RDI support
Leverage: The grants have limited leverage due to the high co-financing rate by the EU. For the RSFF however the leverage has been estimated to be in the order of 1-14, which would mean for the present period an estimated total of €14 billion. With a similar leverage the RSFF could potentially generate over €50 billion for Horizon 2020, nearly doubling the innovation funds of the EU budget and directly investing in the economic potential of Europe.
European Value Added: EU-level RDI is of a high European Value Added due to the strong economies of scale and efficiency gains it provides. The multiplier effect on the economy is expected to be very high. Assuming that the OECD estimates are upheld, the total value added for business would reach €650 billion, which is probably much higher under Horizon 2020. The export, employment and growth effects are significant, worth a 5.6% of higher steady state level of GDP in the long-run.
Additionality: The need for risk capital is large in Europe, which is lagging behind its international competitors in private and public risk capital. The demand gap is considered substantial and instruments like the RSFF are needed.